The Bank of Canada is widely expected to deliver a final quarter-point interest rate increase on Wednesday before pausing its historic monetary policy tightening cycle.

Central bank officials signalled in December that they were nearing the end of their inflation-fighting campaign, in which they increased borrowing costs seven consecutive times last year. They said the choice between pressing on with further rate hikes or hitting pause would depend on coming data.

Since then, most economic indicators have come in stronger than expected. Unemployment remains near a record low and consumer spending is holding up relatively well in the face of higher prices and rising borrowing costs. Inflation continues to trend downward, hitting an annual rate of 6.3 per cent in December from a peak of 8.1 per cent in June. But it remains well above the central bank’s 2-per-cent target.

The momentum of the Canadian economy through the fourth quarter of 2022 raises the odds of another rate hike this week – although for the first time in nearly a year, another is not guaranteed. Most Bay Street analysts expect a quarter-point move and financial markets are pricing in a roughly 70-per-cent chance of this happening. That would take the bank’s benchmark lending rate to 4.5 per cent.

“We’re looking for a 25-basis-point hike next Wednesday, but there’s two-way risks around that,” said Josh Nye, senior economist at Royal Bank of Canada. “We could see them pause, or could even see another 50-basis-point hike. They’ve kind of left a lot of options on the table.” (A basis point is one hundredth of a percentage point.)

Most analysts expect this to be the last push in the current tightening cycle. The Bank of Canada has not yet brought inflation to heel. But interest rate changes work with a considerable lag, often taking six to eight quarters to have a full impact on inflation. In effect, much of the pain from the 2022 rate increases has yet to be felt beyond the housing market.

This could change in the coming months. Consumer spending is expected to contract as more homeowners renew their mortgages at higher rates and nervous shoppers cut back on non-essential purchases. A pair of Bank of Canada surveys published last week found that the majority of businesses and consumers expect a recession in the next year. The central bank itself is forecasting that the economy will stall through the first half of 2023, posting near zero growth.

The bank is intentionally slowing down the economy, raising borrowing costs to curb spending on goods and services and slow the pace of price increases. But it’s trying not to overdo it – a difficult task given the lag time between rate hikes and their intended effect.

“We are trying to balance the risks of over- and undertightening monetary policy,” Bank of Canada Governor Tiff Macklem said in a December speech.

“If we raise rates too much, we could drive the economy into an unnecessarily painful recession and undershoot the inflation target. If we don’t raise them enough, inflation will remain elevated, and households and business will come to expect persistently high inflation.”

He added that not doing enough posed the “greater risk.”

Other central banks face similar balancing acts as they slow the pace of monetary policy tightening and approach a pivot point. The U.S. Federal Reserve is expected to announce a 25-basis-point rate increase on Feb. 1, bringing the Federal Funds Rate up to a range of 4.5 per cent to 4.75 per cent.

Most Fed officials indicated in December that they expect the policy rate will exceed 5 per cent by the end of 2023. However, traders and investors have begun to doubt the U.S. central bank will get that far. Financial markets are pricing a terminal policy rate of 4.75 per cent to 5 per cent.

Whatever the path forward, don’t expect officials at either the Bank of Canada or the Federal Reserve to suddenly sound dovish, said James Orlando, senior economist at Toronto-Dominion Bank. Bond yields have already fallen in recent months, and central bankers may be wary of financial conditions loosening more than they intend if they stop talking tough on inflation.

“They can’t just say, ‘We’re done, set it and forget it.’ They’re going to have to make sure that everything is moving in the direction that they thought,” Mr. Orlando said. “If we keep seeing blowout employment numbers, which is going to lead to greater consumer spending potentially, then maybe they have to hike again.”

The strength of the labour market presents a particular challenge for the central bank. Canada added 104,000 jobs in December, and the unemployment rate dropped to 5 per cent, only slightly above a record low of 4.9 per cent reached last summer.

The tight job market is fuelling wage growth. That’s good news for Canadian workers, but it makes the central bank’s inflation-control job harder, as rising wages feed through to inflation, especially in the service sector. Mr. Macklem argued in a November speech that unemployment would need to rise and job vacancies fall to get inflation back to target.

The latest Consumer Price Index data, published by Statistics Canada last week, suggests inflation is moving in the right direction. The annual rate of CPI growth fell to 6.3 per cent in December, from 6.8 per cent in November, led by a sharp drop in gasoline prices. Core inflation measures, which capture underlying price pressures in the economy, remain stubbornly high, but they have begun to decelerate.

Economists expect inflation to keep moving down. The jump in energy and other commodity prices that occurred in the spring of 2022 will fall out of the annual data in the coming months. Prices for durable goods are already flatlining or even falling, as supply chains improve and demand dips for non-essential products.

The central bank said in October that it expects CPI inflation to be around 3 per cent by the end of 2023, and back at the 2-per-cent target by the end of 2024. The bank will publish new inflation and economic growth forecasts on Wednesday.

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